The Black Swans of KSA's Vision 2030

During the global financial crisis it became fashionable to identify the so-called ‘Black Swans’, events that apparently came from nowhere [often] with devastating effect, though in retrospect they were hiding in plain sight.

There are two ‘Black Swans’ which have implications for Vision 2030, Saudi Arabia’s 15-year plan to wean itself from its current dependency on oil revenues. These have forced the country’s socio-economic and climate change policies to be interwoven, creating significant, but not insurmountable challenges for the power sector.

Black Swan 1: The oil paradox

The title of the 2011 Chatham House report, “Burning Oil to Keep Cool”, captures the essence of a basic problem. It estimates that Saudi Arabia’s consumption of its own oil and gas is growing at around 7% per year and demand for power is especially high during the summer months, as air-conditioning units run at maximum capacity for extended periods. Desalinated water production is also a very significant domestic consumer of hydrocarbons.

Heavily subsidised power and water have been part of the social compact in Saudi Arabia for decades. Both cool air and portable water are funded by exporting oil resources, the Kingdom’s primary source of revenue. Those abroad who fill their tanks with Saudi oil have therefore, albeit indirectly, been funding this compact. At the same time, those oil-importing countries have enjoyed the significant benefit of exporting into the Saudi market. The downside of that position is a lack of private sector employment in the Kingdom itself, one of the key challenges which the Vision is intended to address, with a planned 6mn additional jobs by 2030 and a particular emphasis on education reform.

Moving to anything approaching cost-reflective tariffs for electricity and water is likely to be a painful, but ultimately necessary adjustment, if the value in the primary asset of the Kingdom is to be realised and invested, and not dissipated in its own domestic market.

Black Swan 2: Climate change

The global temperature for February 2016 was far above the long-term average, causing shock among climate observers. March 2016 set a new record temperature for that time of year, according to NASA’s Goddard Institute for Space Studies. The global temperature was 1.28oC warmer than the average for March from 1951 to 1980, which is used as a baseline. Recently, the world’s two biggest-emitting nations have formally ratified the UN Paris Agreement on climate change, making it likely that the treaty, which will establish a new international carbon trading mechanism after 2020, will enter into force this year.

The clear message is that the longer we wait, the more expensive it will be to mitigate the effects of climate change. The next landmark report from the UN climate science panel, due to come out in three stages between 2020 and 2022, will look more closely at policies for managing this challenge, and will have profound implications for Saudi Arabia.

The Intended Nationally Determined Contribution (“INDC”) of Saudi Arabia under the United Nations Framework Convention on Climate Change (“UNFCCC”) identifies two development baseline scenarios, one reliant on heavy industrialisation, which seems less likely; and the other envisaging economic diversification with a robust contribution from oil and its derivatives, with revenues channelled into investments in high value-added sectors such as financial services, medical services, tourism, education, renewable energy, and technologies to enhance economic growth.

Thus, in relation to Vision 2030, climate change is a Black Swan, because its acceleration, in terms of temperature increase and also in terms of political imperatives, is rapidly narrowing the goalposts for a sector already balancing rising domestic demand with reduced oil prices.

Investor issues

Successful future investment is likely to have certain characteristics. In the Saudi context, the Saudi Electricity Company (SEC) has a fundamental role on the supply side. There have been indications that the government, the 80% shareholder, is considering restructuring it into generation, transmission, and distribution companies. This is a relatively well-trodden path globally and many good lessons can be applied.

As regards to renewables, a new wave of technology is being developed with enhanced generation and storage features; the Kingdom is actively participating in this already. Last year, it was announced that hot sand concentrated solar power, which does not suffer the degradation issues existing solar technologies encounter in conditions of extreme heat and dust, is set to become a commercial reality. This will bring significant environmental and cost benefits, especially as regards rural power generation.

Globally, we are faced with the consequences of our failure to wean ourselves from our “addiction to oil”. The young people of the Kingdom, and their peer group across the world, will inhabit that new reality. But, as will be gleaned from the above, there are many “moving parts”, each of which, to a greater or a lesser extent, depends on the others. Sooner rather than later, some hard choices will have to be made, based on a critical, iterative analysis of what is a fluid, developing, and complex situation. The correct combination of educational and energy policies, therefore, represents the single most important element of Vision 2030.